Progress Software Corporation — Q3 FY2013 Form 10-Q
Reporting period: Three and nine months ended August 31, 2013. Financial statements are unaudited. Comparatives have been revised to present divested businesses, including Apama, as discontinued operations.
Business context
Progress is shifting its strategy toward cloud and mobile application development and deployment, including the application Platform-as-a-Service (aPaaS) market. It divested its non-core product lines and sold Apama to Software AG in July 2013. In July it launched Progress Pacific, combining Rollbase with existing products. The May 2013 Rollbase acquisition supports this strategy.
Financial performance
| Metric | Q3 FY2013 | Q3 FY2012 | Nine months FY2013 | Nine months FY2012 |
|---|---|---|---|---|
| Revenue | $77.6m | $74.4m | $243.0m | $231.0m |
| Gross profit / margin | $69.1m / 89% | $64.9m / 87% | $216.1m / 89% | $204.3m / 88% |
| Operating income / margin | $9.7m / 12% | $11.3m / 15% | $39.8m / 16% | $49.1m / 21% |
| Continuing-operations income | $7.2m | $7.7m | $25.2m | $32.5m |
| Net income | $24.8m | $5.8m | $59.9m | $11.4m |
| Diluted EPS | $0.46 | $0.09 | $1.06 | $0.18 |
Revenue rose 4% in Q3 and 5% for the nine-month period as reported (6% for nine months on a constant-currency basis). License revenue grew 13% and 17%, respectively; maintenance and services revenue was essentially flat. License growth was principally driven by OpenEdge and Corticon. Q3 revenue was flat in North America, while EMEA grew 15% as reported; Latin America declined 20%.
Gross margin improved, reflecting higher license revenue and lower maintenance and services costs. Operating income declined despite revenue growth, as higher product-development, restructuring and acquisition-related expenses more than offset gross-profit gains. Product-development expense increased 29% for the nine months, partly due to investment in Progress Pacific and costs formerly supporting divested product lines.
Net income includes discontinued-operation gains, not just ongoing performance. Q3 discontinued operations contributed $17.6m after tax, including the Apama sale gain; the nine-month contribution was $34.7m. The nine-month pre-tax gains included $35.9m from Apama and $35.1m from other product-line sales. Excluding discontinued operations, continuing-operations income fell 7% in Q3 and 22% for the nine months.
Cash, liquidity and capital
- At August 31, cash and cash equivalents were $215.3m and short-term investments were $26.6m, totaling $242.0m; total assets were $686.6m. Shareholders’ equity was $519.4m.
- Operating cash flow was negative $13.3m for the nine months, versus positive $75.7m a year earlier. Management attributed the decline mainly to $56.3m of income-tax payments related to divestitures and higher annual bonus payments.
- Investing cash flow was positive $125.2m, including $111.1m of net divestiture proceeds. Financing cash flow was negative $193.7m, including $241.2m of share repurchases.
- No borrowings were outstanding under the $150m revolving credit facility; $0.4m of letters of credit were outstanding. The facility matures in August 2016. The company reported compliance with its covenants by a significant margin.
- The company repurchased 10.3m shares for $237.4m during the nine months; cumulative repurchases under its $360m authorization were $325.8m through August 31. It reported $84.7m repurchased under the active plan through October 2.
- Auction-rate securities had a fair value of $26.6m, with $4.1m of temporary unrealized impairment. These securities lack short-term liquidity. Management said cash, expected operating cash flows and credit availability should cover foreseeable needs for at least 12 months.
Outlook, risks and unusual items
No specific revenue or earnings guidance is provided. Management expects continued investment in product development and cloud operations, and cautions that sustainable revenue increases may not be foreseeable in the near term and operating margins may be adversely affected while investments are made. It expects approximately $1.7m of additional 2013 restructuring costs through the remainder of FY2013; most 2012 restructuring costs are not expected to recur materially.
Key risks include the execution of the cloud/aPaaS transition, competition from larger or more experienced cloud vendors, changes in customer demand and pricing, foreign-exchange exposure, and the potential disruption and cost effects of restructuring and divestitures. The company also noted that divestitures reduce future revenue and cash flows, alongside the elimination of associated direct costs.
Internal controls: Management concluded disclosure controls were not effective at the reasonable-assurance level because of a material weakness related to documenting customer and partner contract terms and revenue recognition. Remediation steps had been implemented, but the weakness was not considered remediated; effectiveness was still being evaluated through fiscal year-end.
Other contingencies: A $1.0m indemnification obligation related to the sale of Artix, Orbacus and Orbix had a maximum exposure of $11.3m; management expected substantial resolution within six months. The Apama sale included $4.5m held in escrow for up to 18 months.
Important facts for investors to verify
- How much of reported net income and EPS reflects divestiture gains versus recurring continuing operations.
- Whether license growth, maintenance renewals and revenue backlog remain sustainable after product-line sales; the filing cautions that backlog is not necessarily a reliable indicator and is not fully comparable year over year.
- Progress and cost of the cloud/aPaaS strategy, including the revenue contribution and integration of Rollbase and Progress Pacific.
- Cash conversion after the unusual tax payments, planned buybacks and restructuring outlays; assess liquidity separately from illiquid auction-rate securities.
- Whether the revenue-recognition material weakness is remediated and controls operate effectively after the new order-management system implementation.